sh 1003-shariah rules assignment

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1 Islamic Finance within Trading Framework: The Way to Legitimate Profit

Islamic Finance within Trading Framework:

The Way to Legitimate Profit

Submitted By

Mohsin Ali

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Submitted To

Prof. Dr. Zainal Azam Abdul Rahman

Date of Submission: November 20th, 2011

Semester: September – December 2011

Shari`ah Rules in Financial Transactions

SH 1003

http://www.inceif.net/

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Table of contents

1. What is trading framework?

2. Trading Framework in Islam: An Introduction

3. Trading under Islamic Law of Commercial Contract

3.1 Valid Contract

3.1.1 Statement of Contract and its Conditions

3.1.2 Two Contracting Parties and their Conditions

3.1.3 Subject Matter of a Contract and Its Conditions

3.1.4 Prices

3.2 The Prohibited Elements in Shariah Commercial Contracts

3.2.1 Duress (Ikrah)

3.2.2 Mistake (Ghalat)

3.2.3 Inequality (Ghubn)

3.2.4 Deception (Taghrir)

3.2.5 Contracts for Forbidden Things

3.3 Options in Sales (Khiyar)

4. Trading Practices/ Financial Transactions Disallowed in Islam

4.1 Basic Prohibitions

4.1.1 Riba

4.1.1.1 Riba in Debt

4.1.1.2 Riba in Sale

4.1.2 Prohibition of Gharar

4.1.2.1 Gharar in Salam and Istisna

4.1.2.2 Prohibitted types of sale due to Gharar

4.1.2.3 Conditional sales and “two bargains in one sale”

4.1.2.4 Bai„ al-arbun (downpayment sale)

4.1.2.5 Bai„ al dayn (sale of debt)

4.1.3 Prohibition of Maisir/Qimar (Games of Chance)

4.2 Other Prohibitions

4.2.1 Sale of impure objects

4.2.2 Town dweller is not allowed to sell the goods of a desert-dweller

4.2.3 Najash

4.2.4 Prohibition of meeting carvans on the route

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4.2.5 Persuading buyers to cancel their purchases from other vendors

4.2.6 Commodity used in the commission of sin

4.2.7 Earning of a prostitute, the price of a dog and the earning of a cupper

4.2.8 Trading at the time of Juma Prayer

4.2.9 Monopoly business

4.2.10 Speculative business based on selfish interest

5. Profit in Islam

6. Other Financial Transactions

6.1 Profit sharing transactions

6.2 Leasing (Ijarah)

6.3 Fee based transaction

6.4 Free of Charge transaction

6.5 Supporting Transactions

7. Gray Areas

7.1 Use of hiyal

7.2 Bai‟ al-inah

7.3 Organized Tawarruq

7.4 Murabaha Sukuks

7.5 Equity based Sukuks & Fixed income

8. Difference between Conventional and Islamic trading framework

8.1 Basic Philosophy

8.2 Profit vs Riba

8.3 Time value of money

8.4 Options in sales

8.5 Gharar and speculative activities

8.6 Derivatives

8.7 Dealing in Haram things and activities

9. Government Intervention in Market Place

10. Business Ethics in Islam

11. Summary

12. References

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Islamic Finance within Trading Framework: The Way to Legitimate Profit

1. What is trading framework?

Framework basically means “A hypothetical description of a complex entity or process” and trading can generally

be defined as “The commercial exchange (buying and selling on domestic or international markets) of goods and

services”. So, basically trading framework is a hypothetical description of the process of commercially

exchanging goods and services. Trading framework could be viewed differently from different perspectives. In this

paper our focus would be on describing the process of trading governed by Islamic Principles. So, let us see how

Islam views trade.

2. Trading Framework in Islam: An Introduction

I want to start introducing trade in Islam from a verse from following verse of Holy Quran, in which Allah SWT

has compared between Trade and Interest and declare the permissibility of former and prohibition of latter.

(

Those who devour usury will not stand except as stands one whom the Evil One by his touch Hath driven to

madness. That is because they say: "Trade is like usury," but Allah hath permitted trade and forbidden usury.

Those who after receiving direction from their Lord, desist, shall be pardoned for the past; their case is for Allah

(to judge); but those who repeat (The offence) are Companions of the Fire; They will abide therein (for ever).

(al-Baqarah 2:275)

Literally, Bai„ means exchange of one thing with another; one thing being the subject matter and the other

being price. THE MEJELLE, a code of Islamic commercial law based on the Hanafi Fiqh, defines a sale as “the

exchange of property for property”, and in the language of the law, it signifies an exchange of property for

property with mutual consent of the parties, which is completed by declaration and acceptance.

The word Bai„ in its widest meaning stands for any bilateral contract. In that sense, a simple word for Bai„ would

be “exchange”. This may involve all types of trading activities and any exchange. But all exchanges that lead to

Riba are unanimously prohibited. Similarly, exchanges based on Gharar or absolute uncertainties are void. The

literature of Hadith and Fiqh contains mention of many types of Bai„ that have been prohibited by the Prophet

(pbuh). The common factor of all such prohibited types is that they contained the elements of Riba, deception

and/or Gharar. Trading activity, to become valid, must be free from all false & prohibited practices.

Different exchanges involve different rules in respect of the liabilities and benefits for the parties to exchange,

ownership rights, etc. Exchange in the form of trading involves the reciprocal exchange of property rights along

with usufruct. In Ijarah, which is termed the sale of usufruct, the Lessor gives usufruct against rental but retains

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ownership along with the liabilities relating to ownership. In loans, there is a temporary but complete transfer of

ownership (along with usufruct) to the borrower, who can use the loaned item like his other possessions, but he has

to give it back. Musharakah involves sharing of ownership and benefit/loss among the partners.

In trade, as soon as a sale agreement takes place, ownership of the subject matter is transferred to the buyer,

irrespective of whether he has made cash payment or has to pay in the future according to an agreed schedule. In

the latter case, the buyer is liable to pay the agreed price and not the commodity. In a loan, the item/commodity of

loan is transferred to the borrower and he gets ownership of the item with full discretion about its use. But he has

to repay a similar item/commodity or the money.

While Riba-based loaning involves the definite right of return, Bai„ yields risk-based return. In other words, “risk

and reward” is an essential ingredient of trade, which is inherent in all trading activities. Transaction becomes

usurious if it involves an exchange of two counter values.

A trade transaction requires the transfer of complete and instant ownership that is irreversible once finalized. It

means that the seller excludes the commodity from his ownership and gives it to the buyer on a permanent basis,

while in loans, ownership is transferred for a specified period and exactly its similar has to be paid back (Al Jaziri,

1973). When the genera of the goods to be exchanged in trading are different, delivery of one of the exchanged

items can be delayed, as in a credit sale or as in advance payment for purchase of wheat through Salam. If gold or

any currency is exchanged for wheat or any other commodity, there is no Riba; if wheat is exchanged for barley,

Riba is found if delivery of one is delayed, because they are species of the same genus (Muslim, 1981, with

annotation by Nawavi). Loan transactions, on the other hand, have to be executed on an equal basis for the purpose

of repayment. All banking transactions are covered under this rule and their unequal exchange is tantamount to

Riba. Therefore, as conventional banks deal in money, their transactions cannot be termed as Bai„ in the strict

sense. Renowned Hanafi jurist Sarakhsi says: “Trade is of two kinds: permitted (Halal), which is called Bai„ in the

law; and prohibited (Haram), which is called Riba. Both are types of trade. Allah Almighty informs us, through the

denial of the disbelievers, about the rational difference between exchange (Bai„) and Riba, and says: „That is

because they said Bai„ is like Riba‟. Almighty, then, distinguishes between prohibition and permission by saying:

„And Allah has permitted sale and prohibited Riba‟.”

As in ayah (Al-Baqarah 2:275) mentioned above, trade is one of the admirable professions among innumerable

lawful sources of earnings and Islam has put a tremendous emphasis on it for the acquisition of wealth.

Trading framework in Islam is based on divine knowledge source of which are Quran, Sunnah, Ijma, Qiyas and

Ijtihaad. In other words, the Islamic trading framework is not a product of human thought resulting from any

scientific inquiry: it is a divine direction leading to a unique way of earning legitimate profit. Trading framework

in Islam is governed by Islamic law of commercial contracts. So, now I would like to discuss trading framework in

the eyes of Islamic law, allowable and non-allowable things.

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3. Trading under Islamic Law of Commercial Contract

Islamic law is considered to be the complete code of life containing different aspects of human life including

financial transactions. All of these transactions are basically governed by different types of contracts. Allah says

about the contracts:

“O you, who believe, fulfill your contracts.” (Al-Ma‟idah: 1).

From the viewpoint of soundness and legal affects according to Shariah, contracts are divided into three types:

valid (sahih), imperfect/voidable (fasid), and invalid (batil). These types represent the viewpoint of the Hanafi

School. According to the majority of jurists, however, contracts are divided into two types, i.e., valid and invalid.

These jurists did not make any distinction between imperfect and invalid contracts on the grounds that whatever is

imperfect to the Hanafi School is invalid in their understanding (Dr. Ahcene Lahsasna, 2006).

Here I am only intending to discuss Valid Contract.

3.1 VALID CONTRACT

A valid contract, according to all jurists, is the one that fulfils all of its pillars and conditions, and is not connected

with those attributes that would make it unlawful. In order to form a valid contract following four elements have to

be taken under consideration. These conditions are generally related to four pillars of contract.

1. Statement of Contract

2. Contracting Parties

3. Subject matter of contract

4. Price

Let us discuss necessary conditions related to all these pillars which are required for a valid contract

3.1.1 Statement of Contract and its Conditions:

Without the statement a contract cannot be formed. The Hanafi School of Law maintains that the statement is

considered to be the only pillar of a contract. They opine that other aspects will automatically follow the statement;

other aspects are not considered pillars of a contract. According to the majority of jurists, statement and two other

aspects, that is, two contracting parties and the subject matter are also included among the pillars. Since the

consent of the parties is the primary condition of a contract, and it is an internal and intangible aspect, offer and

acceptance are considered as external proof of the contract. Statement is formed through offer and acceptance.

According to the Hanafi School, offer is what is stated first by one of the two parties, and acceptance is what is

secondly stated by the other party because the latter occurs as consent to what the first party has established. The

majority of jurists maintain that offer is what is stated by the one who transfers the ownership, irrespective of

whether it occurs firstly or secondly. While acceptance is what is said by the one to whom the ownership is to be

transferred, indicating his/her consent to what is offered by the other party. According to a number of

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contemporary jurists, the view of the Hanafi School in this regard is preferred because it is precise and also, by this

standard, differentiation between offer and acceptance becomes easier. Let us now discuss conditions of statement

of a contract.

Use of Past Tense: Jurists prefer the past tense for verbal expression for forming an offer and an acceptance, such

as “I sold,” and “I bought.” This is because although the past tense is originally for the past, according to linguistic

uses, this tense is utilized for instant offer and acceptance. According to most jurists, other tenses such as present,

future, or the command form of a verb, could be utilized for forming a contract depending on the intention,

circumstances, and custom of the parties. Beside verbal expression, writing also could form an offer and

acceptance, irrespective of whether both parties are able to talk, unable to talk, or one is able and the other is

unable. Other than verbal and written expressions, jurists have disputed whether an offer and acceptance are

allowed to be formed through silent consent by means of giving a price and handing over the sold good. The

majority of Muslim jurists opine that this type of offer and acceptance is permitted. Due to the fact that customary

practice of this nature did prevail in the past and it has been continuing the world over until now.

Conformation of Offer to Acceptance: An acceptance must conform to an offer. If this conformity does not

exist, there will be no consent. This conformity could either be explicit or implicit. Without mutual consent of

parties contract cannot be formed.

Clarity of Offer and Acceptance: Both offer and acceptance must be clear and void of ambiguity. In order to

make an offer and acceptance clear, they should be in conformance with the words and terms that are normally

used in the customs of the parties to indicate a particular type of contract.

Connection of Acceptance with Offer: This is related to the principle of sitting of contract. According to the

Islamic system, an acceptance must be connected with an offer. Both should be in the same sitting, if both parties

are present. Jurists dispute on whether a contract is binding immediately following an offer and acceptance, or

parties are allowed to delay for further thinking about it until the end of the session, which is called in Arabic as

khiyar al-majlis . Hanafi and Maliki Schools of Law maintain that a contract is binding immediately following an

offer and acceptance, and parties are not allowed to delay until the end of the session. On the other hand, other

jurists maintain that both parties are allowed to rethink and delay until the end of the session. The second view is

supported by a sahih Hadith: “Both seller and purchaser have the choice (to revoke the contract) unless they have

separated from each other”.

3.1.2 Two Contracting Parties and Their Conditions

Islamic law enables parties with following attributes to enter into a contract:

Puberty: It is must for a valid contract that contracting parties must have attained puberty. A male can attain it

when he starts to ejaculate sperms in his night dreams, while a female can attain it at the onset of menstruation. If

these signs do not appear and they become older, they are considered pubescent, if they reach a certain age.

According to Imam Abu Hanifah, this age is eighteen years for a male and seventeen years for a female. Imam

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Malik considers the pubescent age to be seventeen years for both male and female. There is no text of the Quran or

Hadith with regard to puberty age.

Sanity: For a valid contract, contracting parties must be sane. If both or one of them is insane, no contract is to be

made. If someone temporarily becomes insane and later regains sanity, he is allowed to conclude a contract when

he remains sane, but he is not allowed to do so when insane.

Maturity: Contracting parties must also attain maturity. According to jurists, maturity is: “Good and proper

dealings with wealth from a worldly viewpoint”. If someone is a wrongdoer from the religious viewpoint, yet from

a worldly viewpoint, he is capable of dealing with money and wealth properly without wasting or misusing it, he is

considered to be mature. A person is not allowed to deal with his wealth independently without attaining maturity.

Allah SWT says: “Examine orphans until they reach the age of marriage (i.e., puberty). If you find them matured,

hand over their wealth to them.” (Al-Nisa‟: 6).

If a person possesses all these three qualities, i.e. puberty, sanity and maturity, he is considered to be fully

capable of negotiating and concluding different types of contracts independently.

3.1.3 Subject Matter of A Contract and Its Conditions

The subject matter of a contract can either be a tangible thing (such as money, wealth, goods, etc.), a utility, or a

work. In all these cases the subject matter must fulfill the following conditions:

Suitability of a Subject Matter for a Contract: Muslim jurists have unanimously maintained that a subject

matter must be suitable for concluding a contract on it. If it is not suitable, the contract will be invalid. Following

are the reasons which can make a subject unsuitable for a contract.

If a subject matter is not considered property of value to one of the parties, it is not suitable for forming a

contract e.g. flesh of a dead animal is not considered a property of value to a Muslim.

If a subject matter is not owned by any of the parties, such as water in the river or a deer in the forest, it is

not a suitable subject matter for a contract.

If a subject matter is forbidden by the Shariah, it is not suitable for a contract e.g. a contract is not allowed

to be concluded when the subject matter is swine.

Being of a Subject Matter Known to both Parties: Jurists basically agree that the subject matter of a contract

must be known to both parties. They dispute over whether this condition must be fulfilled in all types of contracts

or not. The Shafi„i School of Law maintains that for the different types of contracts the subject must be known to

both parties. The Hanafi School of Law opines that contracts for donation or charity, such as making a will

(wasiyyah), gift, etc., do not require fulfillment of this condition because ignorance in these types of contracts does

not cause a dispute. The opinion of the Maliki School of Law in this regard conforms to that of the Hanafi School.

It should be noted that a subject of a contract can be known and identified by the contracting parties through

physical viewing at the time of the contract or before the contract or viewing a similar object with the same

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description. It can also be identified by the description of the genus, type and amount in the case where the subject

matter is commonly known by the people or to be delivered in future like in Salam or Istisna contracts.

Capability of a Subject Matter to be Handed Over: All jurists agree that for contracts that involve the exchange

of property, their subjects must be capable of being handed over at the conclusion of the contract. Therefore, a sale

contract for a stray animal, which the seller cannot hand over to the buyer, is invalid. It is not legal to conclude a

contract for performing a job, which is not possible to be accomplished.

Presence of a Subject Matter at the Time of Contract: If the subject of a contract is a tangible thing, it should

normally be present at the time of the contract. The Prophet (pbuh) forbade the selling of a good, which does not

exist. For instance selling grains or fruits before their perfect appearance is not allowed because there is no surety

that they will really appear and grow.

There are following exceptions to this general rule.

Salam and Istisna contracts, as the subject matter is to be manufactured or harvested in future time.

If the subject of a contract is a utility or work, its presence at the time of contract is not required.

Rather, what is required is the strong possibilities of its occurrence in the future like renting a car.

3.1.4 Prices

As a principle, Islam is not inclined to fix prices or profit margins for traders and leaves them to be settled by

the forces of demand and supply. The holy Prophet (pbuh) is reported to have allowed the competitive price

mechanism to balance the demand and supply of goods for the dispensation of economic justice, the best ultimate

benefit of society and for efficient allocation of resources (Tirmidhi, 1988, No. 1336 (also in Abu Daud, 1952,

Kitab al Buyoo)). The limitations are only to take care of some moral, religious and cultural perceptions and

aspirations, which give an important place to the State in ensuring the desired norms.

With regard to pricing, the Islamic Fiqh Council of the OIC, in its fifth session, resolved the following:

i. The basic principle in the Quran and the Sunnah of the Prophet (pbuh) is that a person should be free to

buy and sell and dispose of his possessions and money, within the framework of the Islamic Shariah.

ii. There is no restriction on the percentage of profit a trader may make in his transactions. It is generally left

to the merchants themselves, the business environment and the nature of the merchant and of the goods.

Regard should be given, however, to the ethics recommended by the Shariah, such as moderation,

contention, leniency and indulgence.

iii. Shariah texts have spelt out the necessity to keep transactions away from illicit acts like fraud, cheating,

deceit, forgery, concealment of actual benefits and monopoly, which are detrimental to society and

individuals.

iv. Governments should not be involved in fixing prices except when obvious pitfalls are noticed within the

market and the price, due to artificial factors. In this case, governments should intervene by applying

adequate means to get rid of these factors, the causes of defects, excessive price increases and fraud.

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For a sale to be valid measuring unit of price and price itself is to be ascertained and specified , otherwise the

contract would not be valid.

Sale on Cash and Credit basis: In medieval Islamic trade, not only was buying and selling on credit accepted and

apparently widespread, but also the credit performed many important functions in trade transitions. Most jurists

believe that the seller can indicate two prices, i.e. one for cash and another for a credit transaction, but one of the

two prices must be settled in the same meeting. They, however, qualify this with the condition that the difference

should be a normal practice of the market, the aim should be the business of trade and the seller should not resort

to the practice of Ghaban-e-Fahish. The following tradition is important in this regard: “The person who makes

two bargains in one sale, the lower of the two is lawful for him or he would be charging Riba” (Abu Daud, 1752,

3, p. 274). Jurists like Sem¯ak, Aoz¯aii and others have interpreted this as a situation where a person declares in

the sale contract that in the case of credit, the sale price will be so much, and in the case of cash, so much (Thanwi,

14, p. 273).

A transaction of credit sale with a price higher than the spot price is acceptable. What is prohibited is that the price,

once mutually stipulated, is enhanced due to any delay in its payment. This is because a commodity, once sold,

becomes the property of the purchaser on a permanent basis and the seller has no right to re-price a commodity

that he has already sold, and also because the price becomes a debt.

The difference in price has become a customary factor due to market competition and the free play of market

forces and clients are ready to pay a price for the benefit to be achieved by them of having purchased goods

without making cash payments.

Accordingly, absolute certainty on price is necessary for the validity of a sale. All jurists agree that if one definite

price is not stipulated in the case of a credit sale, it will become Riba and therefore unlawful. Another point to be

clarified is that a person who has bought an asset on credit can sell it onward after taking its possession, even if he

has not made full payment of its price.

3.2 THE PROHIBITED ELEMENTS IN SHARIAH COMMERCIAL CONTRACTS

The elements which are prohibited in shariah contracts are duress, mistake, deception, non‐conformity, and

contracts for forbidden things. I will discuss the one by one.

3.2.1 Duress (Ikrah)

Duress in Islamic jurisprudence is to force someone to do something that he dislikes, but in order to remove the

more harmful aspect, he does so against his consent. For duress to be accepted by Shariah, conditions that must be

fulfilled are

It should be from a person who is able to implement what he has threatened

The compeller must be serious in his threat and

The matter under the threat must be very difficult for the compelled to bear.

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In terms of the effect of duress, contracts are divided into the following two groups.

1. Contracts that are not affected and do not have the possibility of being canceled by joking, such as

contracts of marriage, divorce, and emancipation.

2. Contracts that are affected and do not have the possibility of being canceled by joking are contracts such

as buying and selling, renting, will and mortgage.

Here I will discuss the point of views of jurists only related to second type as the focus of this paper is on trading

activities. Jurists have three different opinions on whether these contracts are valid under duress or otherwise.

1. The majority of jurists maintain that duress causes nullification of these contracts and consent that may

come following the removal of duress is not accepted. They support their view through the Hadith of the

Prophet (pbuh): “Verily Allah has removed from my community mistake, forgetfulness and things for

which they are compelled” (Sunan Ibn Majah). This Hadith proves that if anything is done under duress, it

is not considered.

2. Most Hanafi jurists maintain that duress causes nullification of these contracts, but if consent is given

following the removal of duress, this contract is considered valid.

3. Zufar, a Hanafi jurist, opines that duress makes these contracts dependent on permission of the compelled

contracting party. If he gives permission it becomes a valid contract.

3.2.2 Mistake (Ghalat)

Mistake in Islamic jurisprudence is an assumption about anything, which comes into the brain of a person, but

proves to be inaccurate. In other words, it is that which contradicts reality without intention. Mistake in a contract

is that, following its formation, it becomes clear to a contracting party that the subject matter of the contract

contradicts with what has been contracted for. This mistake could either be in the very essence of a subject, or in

its attribute. For instance, if a person buys a silver ring, but later it has been discovered that it is made of copper,

this is considered to be a mistake in the very essence of the subject matter. On the other hand, if someone buys

Persian carpet, but later it was discovered to be Chinese carpet, it is considered a mistake in attribute because both

belong to the same genus.

In the case of a mistake in the very essence of a subject, a contract is considered as invalid because the difference

in genus makes the subject matter non‐existent and a contract for a non‐existing thing is not valid. If a mistake

occurs in the attribute, a distinction should be made between whether the subject matter was present in the sitting

of the contract or not. If it was absent from the sitting of the contract, the purchaser will have the right to choose

between retaining this contract as valid or canceling it. This is because he has purchased what he has not seen. This

is called the option of seeing (khiyar al‐ru‟yah). If the subject matter was present in the meeting of the contract, a

distinction should be made between whether its attribute was possible to be observed due to its clear appearance,

or it was not possible to be observed due to it being obscure and unclear. This option is called the option to cancel

due to an error in its attribute (khiyar al‐wasf).

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3.2.3 Inequality (Ghubn)

Ghubn in Islamic jurisprudence is inequality of price and subject matter of a contract of exchange, that is, one of

them becomes less or more than the other, which was not known at the time of contract.

Ghubn is divided into two types: insignificant inequality (ghubn yasir), and excessive inequality (ghubn fahish).

All jurists unanimously agree that insignificant inequality does not affect most contracts. This is because it

frequently occurs in financial transactions and people tend to forgive each other for this small amount of

inequality. According to all jurists, excessive inequality causes nullification of contracts that occur for properties

of endowment and state, or wealth of the one who is barred from dealing with his wealth because of being minor

or insane or foolish.

Jurists have different opinions regarding contracts that occur for properties other than those mentioned above. The

majority of jurists maintain that excessive inequality does not absolutely affect these contracts, irrespective of

whether deception has taken place or not. The Hanbali jurists, however, opine that excessive inequality does affect

these contracts absolutely, irrespective of whether deception occurs or not. Therefore, the deceived will have the

right of choice between retaining these contracts as valid or canceling them. Some Hanafi jurists maintain that

excessive inequality affects these contracts, if it occurs because of deception of a contracting party or his

representative. In such situations these contracts are permitted but not legally binding. The deceived will have the

right to retain them as valid or to cancel them. But if this inequality does not occur because of deception of a

contracting party, these contracts will remain valid and legally binding.

3.2.4 Deception (Taghrir)

Deception in Islamic jurisprudence is to induce a contracting party to think that it is in his interest to take the

subject matter whereas in fact it is not so. Deception is divided into two types: deception related to statements

(taghrir qawli) and deception related to deeds (taghrir fi„li).

Taghrir Qawli (Deception Related to Statement): Taghrir Qawli occurs because of the deception of one of two

contracting parties or his representative in order to induce the other party to conclude a contract even if it happens

with inequality. For example, if a seller tells a lie to a purchaser that someone has proposed to give him such an

amount of price for his good, and the purchaser is induced with this statement to purchase it at the mentioned

price, it is considered to be a deception related to statements. This type of deception is forbidden in Islam, for

which the deceiver will be punished on the Day of Judgment. But the contracts are not affected and they will

remain valid and legally binding except where an inequality occurs for a contracting party because of this

deception, then the deceived will have the right to retain it as valid or to cancel it.

Taghrir Fi„li (Deception Related to Deeds): Taghrir Fi„li is deception that occurs through doing something on

the subject matter to show it in a condition that contradicts its reality. For example, if someone paints an old house

to show it as new, it is considered to be a deception related to deeds. All jurists agree that if this type of deception

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occurs, it will affect the contract and make it legally not binding. Therefore, the deceived will have the right to

cancel such a contract.

3.2.5 Contracts for Forbidden Things

Liquor and pork: No contract should be made for selling or buying forbidden products such as alcohol, pork, or

any other forbidden substances. Allah says: “O you, who believe, eat from good (lawful) foods that I gave you as

sustenance.”(Al‐Baqarah, 2: 172).

The verse indicates that we are not allowed to have our sustenance from things or goods that are forbidden. The

Prophet (pbuh) says: “Seeking lawful sustenance is obligatory for every Muslim.”

No contract should be made for any financial deal on the basis of fixed interest or usury. Usury is forbidden in

Islam. Allah says: “Allah legalised trading, but forbade usury.”(Al‐Baqarah, 2: 275). He also says: “O you, who

believe, do not eat usury…” (Ali `Imran, 3: 130).

He states: “O you who believe, fear Allah and abandon receiving whatever amount has been left of usury, if you

are really believers. If you do not do so then be notified about a battle from Allah and His

Messenger.”(Al‐Baqarah, 2: 278‐279).

According to these verses, as in the prohibition of receiving usury, any contract for investment in those companies

and financial institutions that conduct businesses on the basis of usury is also forbidden.

On the contrary, a contract for investment must be conducted according to a profit and loss sharing policy. If there

is profit, both the owner of the capital and the manager would share it according to an agreed percentage, not

according to a fixed percentage of the capital. If there is a loss, the owner of the capital should bear it and not the

second party. However, the second party in this last case would lose in terms of the effort put into the venture. This

is called Mudarabah.

Contract for gambling is forbidden in Islam. Allah says: “Surely drinking alcohol, gambling, etc… are impure and

deeds of Satan, therefore, you should not commit them.” (5:90).

3.3 OPTIONS IN SALES (KHIYAR)

The Shariah demands that the seller should disclose all the defects in the article being sold. Otherwise the sale is

not valid. When a person has made a purchase and was not aware, at the time of sale or previously, of a defect in

the article bought, he has an option, whether the defect is small or big, and he may either be content with it at the

agreed price or reject it. If a seller has sold an asset as being possessed of some specific quality, and that asset

turns out to be without that quality, the buyer has an option to annul the contract. It is to be recognized, however,

that the right to exercise an option is not automatic. It has to be specified at the time of entering into the contract.

This brings us to another extraordinary peculiarity of Islamic law: the doctrine of option or the right of cancellation

(Khiyar). Even when a sale is duly executed, free from any grounds of illegality, it still may not be absolutely

binding on the parties involved if the condition of option is provided in the contract (Khiyar al-Shart).89 So long

as the parties do not leave the place of contract, any of them can cancel the deal (Khiyar al-Majlis). However, if it

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is stipulated that the contract has been finalized even if the parties do not separate, Khiyar al-Majlis will not be

available (Al Jaziri, 1973).

The Shariah literature discusses the concept of option in trade wherefrom we conclude that the informationally

disadvantaged party at the time of entering into the contract can have the option to cancel the contract within a

specified period. The Prophet (pbuh) himself recommended to one of his Companions to reserve an option for

three days in all his purchases. Jurists are unanimous on the validity of this kind of option. However, they differ on

options for more than three days. Such option stipulation can be reserved by either of the parties.

Aside from this, the purchaser has an option without any stipulation with regard to things he has purchased without

seeing, and also on account of defects in the commodity being sold. The greatest of all defects is the lack of a title

or of the right to sell on the part of the seller. The parties can also agree that if payment is not made within three

days, the contract will be annulled. This is called an option of payment (Khiyar-e-Naqad). This sale would be valid

only if payment was made within the specified number of days.

The following five types of options among various forms discussed in Fiqh books are important but I am referring

“Al Jaziri, 1973”:

Khiyar al-Shart: a stipulation that any of the parties has the option to rescind the sale within so many (specified)

days; this is also termed Bai„al Khiyar.

Khiyar al Ro‟yat: an option to be exercised on inspecting the goods – goods, if not according to the contract, can

be returned after inspection if such an option has been provided for in the sale agreement.

Khiyar al „Aib: an option with regard to defect – goods can be returned if found to be defective; this kind of

option is available even if no such condition is stipulated in the contract if the defect was not brought to the notice

of the buyer at the time of the contract and the defect caused a visible decrease in the value of the sold commodity.

However, if the seller declares at the time of the contract that he will not be held responsible for any defect in the

commodity, the contract is valid according to Hanafis.

Khiyar al Wasf: the option of quality – where goods are sold by specified quality, but that quality is absent, the

goods can be returned.

Khiyar-e-Ghaban: the option relating to price – where goods are sold at a price far higher than the market price,

and the client is told or given the impression that he has been charged the market price.

As regards the Khiyar al Ro‟yat, jurists differ as to whether the sale of unseen items is binding or not. Ibn Hazm

contends that if a person purchases an unseen commodity but the seller has sufficiently described its features and

the commodity conforms to those features, it would be unjust not to purchase the commodity by using Khiyar al

Ro‟yat. Shaikh Al Dhareer, 1997 writes in this regard: “The Hanafis and the Shafi‟is have held in one view that the

sale is not binding on the buyer. Upon viewing, he can revoke it or ratify it. It means that he has the option of

(rejecting) upon seeing the object even if it is found to be consistent with the manner described; for not seeing the

object obstructs the completion of the transaction. Since this sale is known as the sale with the option of seeing, it

must include such option. The Malikis and the Shafi‟is have held, in one of their views, and so did the Hanbalis,

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that the sale is binding on the buyer should he find the object corresponding to the way earlier described to him.

But if he found it different, he has the option either to ratify the sale or to revoke it. This is a manifestly cogent

view”.

In Salam and Istisna„a, Khiyar al Ro‟yat is not available if the goods are according to the specifications already

stipulated. In the case of Murabaha to Purchase Orderer, the client would have the options of defect and

specification/quality. If the assets or the goods required by the client are not according to the stipulated

specification or have any material defect, the client will have the right not to purchase the goods as per his

promise, and if Murabaha is executed, he will have the right to rescind the sale unless the bank gets a certificate of

fitness just at the time of the sale after giving the client sufficient opportunity to examine the asset.

In the next section of this paper I would discuss these forbidden things in detail and would add some other

disallowed trading practices in Islam.

4. Trading Practices/ Financial Transactions Disallowed in Islam

I have divided prohibited activities in trading in Islam in to two categories i.e. Basic prohibitions and other

prohibitions. In basic prohibitions Riba, Gharar and Gambling are included, first I will discuss them one by and

then will proceed for other prohibitions.

4.1 Basic Prohibitions:

4.1.1 Riba

Riba in Loan/ Debt: I want to start with following verses of Holy Quran:

O ye who believe! Fear Allah, and give up what remains of your demand for usury, if ye are indeed believers.◙ If

ye do it not, Take notice of war from Allah and His Messenger: But if ye turn back, ye shall have your capital

sums; Deal not unjustly, and ye shall not be dealt with unjustly.◙ If the debtor is in a difficulty, grant him time Till

it is easy for him to repay. But if ye remit it by way of charity, that is best for you if ye only knew.◙ And fear the

Day when ye shall be brought back to Allah. Then shall every soul be paid what it earned, and none shall be dealt

with unjustly.◙ (al-Baqarah 2:278-281)

O ye who believe! Devour not usury, doubled and multiplied; but fear Allah; that ye may (really) prosper. ◙ Fear

the Fire, which is prepared for those who reject Faith: ◙ (Aale Imran 3:130-131)

From the above references from the Quran we can derive a number of results regarding the severity of the sin of

Riba, its forms and its connotation. First, indulging in Riba-based transactions is tantamount to being at war with

Allah (SWT) and His Messenger, which no one should even think of. Not only the lenders but also borrowers and

other parties involved commit sin by paying interest or by giving a helping hand in interest based business. If a

destitute is constrained to borrow on interest in case of compulsion to fulfill his basic food needs, there is the

possibility of granting limited permission to borrow on interest. But a person who takes advantage of interest-

based loans for luxurious consumption or for the development of his businesses is culpable as per the above

doctrine.

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A loan (Qard) is any commodity or amount of money taken from any other person with liability to return or pay

back the same or similar commodity or amount of money when demanded back by the creditor. A debt (Dayn) is a

liability to pay which results from any credit transaction like a purchase/sale on credit or due rentals in Ijarah

(leasing). The amount of debt has to be paid back at a stipulated time and the creditor (in case of debt) has no right

to demand payment of the debt before the mutually agreed time. The principle that the Holy Quran has given in

verses 2: 278 and 279 is that in both loans and debts, the creditor has the right to the principal amount only; in the

former case, exactly the amount given as the loan and in the latter case, the liability or the amount of debt

generated from the credit transaction. Any amount, big or small, over and above the principal of loan or debt

would be Riba. As conventional banks‟ financing falls into the category of loans on which they charge a premium,

it falls under the purview of Riba as prohibited by the Holy Quran. As such, there should be no doubt that

commercial interest as in vogue is Riba in the light of the principle given by the Holy Quran.

The word “Riba”, meaning prohibited gain, has been explained in the Holy Quran by juxtaposing it against (profit

from) sale. It explains that all income and earnings, salaries and wages, remuneration and profits, usury and

interest, rent and hire, etc. can be categorized either as:

• Profit from trade and business along with its liability – which is permitted; or

• Return on cash or a converted form of cash without bearing liability in terms of the result of deployed cash

or capital – which is prohibited.

Riba, according to the criterion, would include all gains from loans and debts and anything over and above the

principal of loans and debts and covers all forms of “interest” on commercial or personal loans. As such,

conventional interest is Riba.

Riba in Sale: For elaborating Riba in sale and its prohibition, I want to start with following three ahadith of

Prophet Muhammad (pbuh):

i. The holy Prophet (Pbuh) said, “Gold for gold, silver for silver, wheat for wheat, barley for barley,

dates for dates and salt for salt – like for like, equal for equal, and hand to hand; if the commodities

differ, then you may sell as you wish, provided that the exchange is hand to hand.” (Muslim, 1981,

Kitab al Musaqat, chapter on Riba)

ii. Bilal (Gbpwh) once visited the Messenger of Allah (pbuh) with some high quality dates, the Prophet

(pbuh) inquired about their source. Bilal explained that he traded two volumes of lower quality dates

for one volume of that of the higher quality. The Prophet (pbuh) said: “This is precisely the forbidden

Riba! Do not do this. Instead, sell the first type of dates, and use the proceeds to buy the others.” (Ibid)

iii. A man deputed by the holy Prophet (pbuh) for the collection of Zakat/Ushr from Khyber brought for

him dates of very fine quality. Upon the Prophet‟s asking him whether all the dates of Khyber were

such, the man replied that this was not the case and added that he exchanged a Sa„a (a measure) of this

kind for two or three (of the other kind). The holy Prophet replied: “Do not do so. Sell (the lower

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quality dates) for dirhams and then use the dirhams to buy better quality dates. (When dates are

exchanged against dates) they should be equal in weight.”(Ibid)

Traditions mentioned above relate to the prohibition of Riba in sale or exchange contracts. In particular, the first

tradition forms the basis of elaborate juristic rules on Riba prohibition in sale contracts and other exchange

transactions. This type of Riba is termed as “Riba Al-Fadl”.

Exchange rules are different for different contracts and types of assets. Assets could be consumables, durables,

monetary units or media of exchange like gold, silver or other currencies, shares representing pools of assets, etc.

Goods other than monetary units are traded on market-based pricing. Gold, silver or any monetary units (Athman)

are governed by specific rules that have been discussed by jurists under the caption of Bai„ al Sarf (sale of

Athman). Usufructs and services are covered by the rules of Ijarah or Ujrah (leasing/hiring of services). Loans and

debts are governed by the rules relating to their repayment and assignment.

The well-known Hadith on the exchange of six commodities and the other traditions about the exchange of low

quality dates for a lesser amount of better quality dates deal with Riba in exchange transactions and have far-

reaching implications in respect of business activities in the Islamic framework. Later jurists have extended the

scope of this kind of Riba to other commodities on the basis of analogical reasoning (Qiy¯as) and the „Illah

(effective cause) of prohibition (Muhammad Ayub, 2007).

According to the rules of exchange of monetary units (Bai„ al Sarf), if any article is sold for an article of the same

kind, the exchange must be on the spot (without delay) and the articles must be equal in weight. In this context,

jurists have held lengthy discussions, keeping in mind the two types of „Illah that play an effective role in the

exchange: the unit of value and the edibility. The commentator of Sahih Muslim, Imam Nawavi has summarized

these rules in the following way:

• When the underlying genus of the two goods being exchanged is different, shortfall/excess and delay both

are permissible, e.g. the exchange of gold for rice or Rupees for a car.

• When the commodities of exchange are similar, excess and delay both are prohibited, e.g. dates for dates

or wheat for wheat, dollars for dollars, etc.

• When the commodities of exchange are heterogeneous but the genus is the same, as in the case of

exchanging gold for silver or US Dollars for Malaysian Ringgits (medium of exchange) or wheat for rice

(the „Illah being edibility), then excess/deficiency is allowed, but delay in exchange is not allowed.

In the present scenario, the major cause, on the basis of which one may extend the rules of Riba to other

commodities by analogy is their being used in lieu of money. There is consensus among scholars that the rules of

Riba apply to anything that serves the function of money. This may be gold, silver or any paper currency.

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4.1.2 Prohibition of Gharar

The second major prohibition is that of Gharar, which refers to the uncertainty or hazard caused by lack of clarity

regarding the subject matter or the price in a contract or exchange. A sale or any other business contract which

entails an element of Gharar is prohibited. “Gharar” means hazard, chance, stake or risk. Gharar is found if the

liability of any of the parties to a contract is uncertain or contingent; delivery of one of the exchange items is not in

the control of any party or the payment from one side is uncertain. In the legal terminology of jurists, “Gharar” is

the sale of a thing which is not present at hand or the sale of a thing whose “Aqibah” (consequence) is not known

or a sale involving hazard in which one does not know whether it will come to be or not, e.g. the sale of a fish in

water, or a bird in the air (Muhammad Ayub, 2007).

Uncertainty cannot be avoided altogether in any business. Risk-taking is rather a condition for the entitlement to

profit in business. The problem, however, was that the extent of uncertainty making any transaction Haram had not

been clearly defined. Lately, scholars have differentiated between too much and nominal uncertainty and declared

that only those transactions that involve too much or excessive uncertainty in respect of the subject matter and the

price in a contract should be prohibited. Therefore, although it has been more difficult to define than “Riba”, a

consensus has emerged in the recent past regarding its extent rendering any transaction valid or void. Accordingly,

Gharar is considered to be of less significance than Riba. While the slightest involvement of Riba makes a

transaction non-Shar¯ı´ah-compliant, some degree of Gharar in the sense of uncertainty is acceptable in the

Islamic structure of business and finance.

Gharar in Salam and Istisna: According to Shar¯ı´ah scholars, to become prohibited, a hazard or uncertainty

would be major and remunerative, e.g. when involved in sale contracts it should affect the principal aspects of the

contract, and it may not be the need of any valid contract like that of Salam and Istisna„a. Gharar can be avoided if

some standards of certainty are met, such as in the case of Salam, where a number of conditions are required to be

fulfilled. The vendor must be able to deliver the commodity to the purchaser. Therefore, Salam cannot be

conducted in respect of those goods that are normally not available in the market at the stipulated time of delivery.

It is prohibited to sell any undeliverable goods. The commodity must be clearly known and its quantity must be

determined to the contracting parties.

Prohibitted types of sale due to Gharar: Gharar relates more to “uncertainty” than to risk as used in commercial

terminology. This uncertainty relates to the existence of the subject matter, rights of or benefits to the parties and

the consequences of the contract. Gharar also means deception through ignorance by one or more parties to a

contract. Following are some types of sales which have been prohibited by Prophet (pbuh) due to Gharar:

1 BAI' AL-MA'DOUM NON-EXISTENT

2 BAI' AL-KHATTAR ITEMS IN DANGER OF NOT BEING FOUND

3 BAI' AL-MAHAMEEN SPERM MALE ANIMALS

4 BAI' AL-MALIQIH EGGS OF FEMALE ANIMALS

5 BAI' AL-NABAL AL-HABALA FETUS IN WOMB OF FEMALE ANIMALS

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6 BAI' AL-MA'JOUZ SOMETHING IMPOSSIBLE TO DELIVER

7 BAI' AL-QANIS SOMETHING BEFORE POSSESING IT

8 BAI' AL-GHA'ISS DIVERS CATCH' BEFORE SEEING IT

9 BAI' AL-MUZABANA FRUIT ON TREE FOR DATES /MONEY

10 BAI' AL-MUHAQALA HARVESTED WHEAT FOR UNHARVESTED

11 BAI' AL-MULMASA BY TOUCH

12 BAI' AL-MUNABAZA BY THROWING

13 BAI' AL-HASSAT BY STONE

14 BAI' AL-MAJHOUL OF UNKNOWN

15 BAI' AL-JAHAL BI AL-AJAL IF UNKNOWN TIME FOR CREDIT

16 BAI' AL-JAHL BI AL-MABI' UNKNOWN QUANTITY/SIZE/WEIGHT ETC.

17 BAI' AL-JAHL BI AL-THAMAN IF PRICE/COST UNKNOWN

18 BAI'

AL-JAHL BI JINSITHAMAN

AW MATHNOUN WHEN KIND/QUANTITY OF GOODS IS ELSEWHERE

19 BAI' ATAN FI BAI

IS TWO SALES IN ONE DEAL +ONE CONDITIONAL UPON

OTHER

20 BAI'

MA LA YURJA

SALAMATAUH NEAR DEATH ANIMAL/SLAVE

21 BAI' AL-MUTAMAL-WUJUDH WHAT MAY NOT BE PRESENT

22 BAI'

AL-MUHTAMAL-

TASLIMUH WHAT MAY NOT BE DELIVERDED

23 BAI' WA SHART IF WITH A CONDITION

24 BAI' AL-GHAIB THE INVISBLE

25 BAI' AL-THAMARA SEEDS' OF TREE BEFORE THEY BECOME FRUIT

26 BAI' MAJHOUL BI MAJHOUL UNKNOWNN FOR UNKNOWN

27 BAI' AL-SOUF WOOL STILL ON SHEEP

28 BAI' AL-LABAN FI DHARI' MILK IN UDDERS OF COW

29 BAI'

BIDOUN HAQ AL-

TASARUF WITHOUT RIGHT TO POSSESION

30 BAI' AL-HAYAT WA-MAOUT FOR LIMIT OF LIFE OR AFTER DEATH

31 BAI' AL- DAYN SALE OF DEBT

32 BAI' AL-ARBUN DOWNPAYMENT SALE

(Source: http://www.islamicthinkers.com/index/index.php?option=com_content&task=view&id=195&Itemid=26)

I will discuss only following three briefly:

http://www.islamicthinkers.com/index/index.php?option=com_content&task=view&id=195&Itemid=26

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Conditional sales and “two bargains in one sale”: The Shariah does not approve sales that are conditional upon

such matters that may or not may happen due to games of chance. In the Fiqh literature, we come across the

prohibition of two stipulations in a sale: Shartaan fi Ba„ien, or sale with a stipulation, and Bai„wal Shart, which

involves lack of clarity and an unjustifiable benefit to any of the parties. For example, a person says to another: “I

will sell you this car if any third person sells me his car”. Gharar in this transaction pertains to the time of the

meeting, the condition and finalization of the contract. Conditions of gift, marriage, Qard or Shirkah as a part of a

sale contract render it a prohibited contract from the Shariah angle.

The Holy Prophet (pbuh) is reported to have said: “unlawful are a sale and a loan (Bai„ wal Salaf), or two

stipulations in a sale, or a sale of what you do not have.” (Tirmidhi, 1988)

Combining contracts which are conditional upon each other confuses the rights and liabilities of the parties and

obstructs fair remedies in the event of default, thereby opening a door to Riba and Gharar.

Bai„ Al-Arbun (Downpayment Sale): „Arb¯un sale has been defined as a sale of down-payment, with the

condition that if the buyer takes the commodity, the down-payment will become part of the selling price, and if he

does not purchase the commodity, the advance money will be forfeited. Two traditions of the holy Prophet have

been reported in this regard. A Hadith quoted by Imam Malik says that the holy Prophet (pbuh) forbade „Arb¯un

sale. According to another Hadith, Zaid ibn Aslam asked the holy Prophet (pbuh) about „Arb¯un as a part of a sale;

the Prophet permitted it. The majority of traditional jurists accept the Hadith prohibiting „Arb¯un sale due to the

involvement of Gharar. However, Hanbalis allow it (Zuhayli, 1985, 4, p. 508).

We can derive on the basis of the above discussion that in cases of involvement of absolute Gharar or injustice

with the buyer (when he committed to purchase, but cannot do so due to any unforeseen happening), down-

payment confiscation might not be permissible. However, to the extent of a customary practice wherein parties do

business in the market with free consent and any unforeseen events are also taken into account, it would be

permissible on the basis of „Urf. The Islamic Fiqh Council of OIC and AAOIFI have also allowed customary

down-payment sale with the condition that a time limit is specified.

Bai„ Al Dayn (Sale Of Debt): A credit document emerging from any transaction of credit sale represents a debt

which cannot be sold as per Shariah rules due to the involvement of Gharar and/or Riba. A trader selling a

commodity on credit and thus having a bill of exchange, an export bill or a promissory note cannot sell it to an

Islamic bank as they could to a conventional bank. As an alternative, the bank can serve as a trader and purchase

the commodity from its producer and then sell it to others who need it on credit, keeping a margin for itself (Al

Baraka, 1997, No. 9/12, pp. 152, 153). The OIC Fiqh Academy and Sharah scholars in general consider the

sale/purchase of such securities or documents representing debt at a price other than their nominal value

incompatible with the tenets of the Shar¯ı´ah. Even on face value, the sale of debt is allowed only when the

purchaser has recourse to the original debtor, as in the case of Hawalah.

“Al K¯ali bil K¯ali”, a maxim in the Fiqh literature forbidding the sale of debt, means the exchange of two things

both delayed or exchange of one delayed counter value for another delayed counter value. The practice of Bai„ al-

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K¯ali bil K¯ali was prevalent among the pre-Islamic Arabs and was also termed Bai„ al-Dayn bid-Dayn. What is

prohibited by this contract is the purchase by a man of a commodity on credit for a fixed period, and, when the

period of payment comes and he finds he is not able to pay the debt, he says: “Sell it to me on credit for a further

period, for something additional”. The Prophet is reported to have prohibited such a sale. This principle has near

universal application and has earned canonical authority in Islamic law as Ijma„a or consensus (Muhammad Ayub,

2007).

The best example of this practice in the present age is “rollover” in Murabaha, where the banks, in a case of default

on the Murabaha receivable, enter into another Murabaha for giving more time to the client and thus charge more

on their receivables. All Shar¯ı´ah boards and Shar¯ı´ah scholars prohibit this practice and any return on this

account is not considered legitimate income for Islamic banks.

The general principles for avoiding Gharar in sales transactions that can be concluded as: the contracts must be

free from excessive uncertainty about the subject matter and its counter value in exchanges; the commodity must

be defined, determined and deliverable and clearly known to the contracting parties; quality and quantity must be

stipulated; a contract must not be doubtful or uncertain so far as the rights and obligations of the contracting parties

are concerned; there should be no Jahl or uncertainty about availability, existence and deliverability of goods and

the parties should know the actual state of the goods.

4.1.3 Prohibition of Maisir/Qimar (Games of Chance)

The words Maisir and Qimar are used in the Arabic language identically. Maisir refers to easily available wealth or

acquisition of wealth by chance, whether or not it deprives the other‟s right. Qimar means the game of chance –

one gains at the cost of other(s); a person puts his money or a part of his wealth at stake wherein the amount of

money at risk might bring huge sums of money or might be lost or damaged. While the word used in the Holy

Quran for prohibition of gambling and wagering is “Maisir” (verses 2: 219 and 5: 90, 91), the Hadith literature

discusses this act generally in the name of “Qim¯ar”.

According to the jurists, the difference between Maisir and Qim¯ar is that the latter is an important kind of the

former. “Maisir”, derived from “Yusr”, means wishing something valuable with ease and without paying an

equivalent compensation („Iwad) for it or without working for it, or without undertaking any liability against it, by

way of a game of chance. “Qim¯ar” also means receipt of money, benefit or usufruct at the cost of others, having

entitlement to that money or benefit by resorting to chance. Both words are applicable to games of chance

(Muhammad Ayub, 2007).

References from the Holy Qur‟¯an in this regard are:

• “O you who believe! intoxicants and gambling, sacrificing to stones, and divination by arrows, are abominable

actions of Satan; so abstain from them, that you may prosper.” (5: 90)

• “Satan intends to excite enmity and hatred among you with intoxicants and gambling, and hinder you from the

remembrance of Allah, and from prayer; will ye not then abstain?” (5: 91)

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• “They ask thee concerning wine and gambling. Say: „In them is great sin and some benefits for people; but the sin is

greater than the benefits‟.” (4: 219)

Gambling is a form of Gharar because the gambler is ignorant of the result of the gamble. A person puts his money

at stake wherein the amount being risked might bring huge sums of money or might be lost or damaged. Present-

day lotteries are also a kind of gambling.

Maisir and Qimar are involved in a number of conventional financial transactions and bank schemes/products

which Islamic banks have to avoid. Conventional insurance is not Shar¯ı´ah-compliant due to the involvement of

both Riba and Maisir. Governments and public/private sector corporations mobilize resources on the basis of

lottery and draws, which come under the banner of gambling and are, therefore, prohibited. Present futures and

options contracts that are settled through price differences only are covered under gambling.

Lotteries: (some types are permissible): A number of forms of lottery are prevalent, some of which might be

valid, but the majority are invalid from the Shariah point of view. It is necessary to have a test to decide which are

permitted and which are not. An analysis of the Quranic verses and the holy Prophet‟s traditions would show that

in valid lotteries, no one should have any personal right or vested interest in the matter and no one should be

deprived of what he had already had or contributed to the process. Further, if the exigency of a situation dictates

that some out of them have to forego any right or fulfill any liability, the solution in the absence of any other valid

or agreed formula is not to decide arbitrarily but through drawing of lots, as in the case of the holy Prophet Younus

(pbuh).

Again, wherever a donor, grantor or a man in authority has to select some people who have equal footing in order

to confer some right, privilege or concession on them, the matter could be decided by drawing of lots. Such a form

of lottery in such cases is permissible. Sometimes, entrepreneurs offer products whereby, when sold for a price,

any additional product is given to the purchaser as an incentive, without any scheme of drawing of prizes or lots.

This is also permissible as the purchaser knows what he is purchasing and the vendor knows what he is offering

for sale and what its price is. The price being known and the property being sold are available for inspection and

there is no element of chance. Such a sale, though induced and publicized with a reward to attract customers, is not

hit by any provision or tenets of the shariah.

4.2 Other Prohibitions

The Prophet, sallallaahu alayhe wasallam, prohibited some forms of sales that people were known to use during his

time. Wisdom behind this prohibition of some sales is to facilitate ease for people and not to increase prices for

them. Also, it is designed to stop sales that might include risk or trickery and eliminate any sale that might

instigate hatred and enmity amongst people.

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4.2.1 Sale of impure objects

The Messenger of Allah (pbuh) said: Allah and his Messenger have forbidden the sale of wine, dead animals, pigs,

and idols. It was said: •O Messenger of All¯ah, how about the fats of dead animals, which are used for painting

ships, polishing leathers, and lamp oil?• He said: •No, this is forbidden•.. Then, the Messenger of Allah said:

•May Allah punish the Jews, when All¯ah Almighty forbade the fats of dead animals for them, they melted them

and sold them, thus consuming their price unlawfully. (Narrated by authors of 6 books)

4.2.2 Town dweller is not allowed to sell the goods of a desert-dweller

The Prophet, sallallaahu alayhe wasallam, prohibited that a town dweller (urban resident) be allowed to sell the

goods of a desert-dweller (rural resident), as stated in an agreed upon hadeeth. This means that the urban resident

is prohibited from selling the goods of a rural resident on behalf of the latter. This is because the urban resident

might wait until people are in need of the goods and then raise the prices. Anas Bin Malik said, "We were

forbidden to allow a town-dweller to sell the goods of a desert-dweller, even if the latter is a brother from the same

mother and father.” (Agreed upon)

4.2.3 Najash:

The Prophet, sallallaahu alayhe wasallam, prohibited najash. Najash is trickery whereby one offers a high price for

a commodity not intent upon buying it but upon cheating someone else who wants to buy it, even though it is not

worth such an elevated price. Scholars have unanimously agreed on the prohibition of such action if the increase in

price puts the commodity at a higher price than similar items. This prohibition is based on the hadeeth narrated by

Ibn Umar that Allah's Messenger prohibited najsh. (Agreed upon) Even if the price is increased to the price of a

similar commodity, al-jumhoor (the majority of scholars) have gone with the impermissibility of such actions

based on the generality of the hadeeth text. Ibn Hazm, Ibn Abdul-Barr and Ibn al-Arabi, however, held the opinion

permitting such action. Ibn al-Arabi stated that, "If a man sees a commodity that is sold below its actual value and

he increases the value to the correct value, then he should not be accused of najash, especially if he did not have

bad intentions." This is supported by the hadeeth narrated by Imaaam Ahmad that the Prophet, sallallaahu alayhe

wasallam, said, "Leave the people alone, for Allah sustains some from others. Should one ask his brother for a

sincere advice, his brother should give him advice."

4.2.4 Prohibition of meeting carvans on the route

The Prophet, sallallaahu alayhe wa sallam, prohibited meeting caravans on route with the intention of purchasing

goods before the sellers know the market price. Ibn Mas'oud narrated that the Prophet, sallallaahu alayhe

wasallam, prohibited going to meet the vendor on route in an agreed upon hadeeth. Ibnul Qayyim said, "The

Prophet, sallallaahu alayhe wa sallam, prohibited that because it includes deception of the seller who does not

know the market price."

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4.2.5 Persuading buyers to cancel their purchases from other vendors

The Prophet, SAW, prohibited the Muslims from persuading buyers to cancel their purchases from other vendors,

and then sell them his goods. This is tantamount to saying to someone who is buying an item for ten dollars, "I

have the same item for seven dollars for you." The Prophet, sallallaahu alayhe wasallam, also prohibited a Muslim

from entering into a transaction to purchase a commodity when his brother Muslim has already negotiated a

purchase of that same commodity. For example, one says to a vendor selling a commodity to one person for seven

dollars, "I will buy it from you for ten dollars." Ibn Umar narrated that Allah's Messenger, sallallaahu alayhe

wasallam, said, "Do not urge someone to return what he has already bought from another vendor so as to sell him

your own goods. And don't urge a woman who is engaged to someone else to cancel her engagement so that she

can become engaged to you, except with the permission of the other person." (Ahmad)

4.2.6 Commodity used in the commission of sin

It is also prohibited to sell a commodity that might be used in the commission of sin. This would include selling

juice to someone who uses it to make khamr (intoxicants), selling weapons during periods of fitnah (confusion or

instability), or selling a house to someone who will use it for sinful deeds. Allah says, "And do not help one

another in sin and transgression." [5:2] This prohibition is based upon knowledge of the intention or evidence

supporting the suspicion.

4.2.7 Earning of a prostitute, the price of a dog and the earning of a cupper:

All, earning of a prostitute, the price of a dog and the earning of a cupper are forbidden.

Sahih Muslim Book 10, Number 3805: Rafi b. Khadij (Allah be pleased with him) reported: I heard Allah's Apostle

(may peace be upon him) as saying: The worst earning is the earning of a prostitute, the price of a dog and the

earning of a cupper.

4.2.8 Trading at the time of Juma Prayer:

In the 9th verse of surah al-Jumah Allah SWT says; “O you who believe, when the call is made for prayer on

Friday, then hasten to remember Allah and leave your trade….”

On the basis of above hadith all jurist agree on unlawfulness of trading after the adhan for Jumah prayer however

there is dispute among them regarding the validity of contract.

4.2.9 Monopoly business

As monopoly means concentration of supply in one hand, it leads to exploitation of the consumers and the

workers, it has, therefore, been declared unlawful by the Holy Prophet (may peace be upon him). Gigantic trusts

cartels and monopolies should not exist in the Islamic society. The monopoly-dominated economic order betrays

lack of harmony between private and social good and is, thus, a negation of the principle of maximum social

advantage which the Islamic society sets out to achieve.

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4.2.10 Speculative business based on selfish interest

Speculation means buying something cheap in bulk at a time and selling it dear at another and, thus, controlling the

whole market to achieve personal gains. A close observation will reveal that speculators are primarily interested in

private gains regardless of the larger interest of the society. These speculators try to create artificial scarcity of

goods and commodities and thereby create an inflationary pressure on the economy. As the poor masses have to

pay for this. Islam has condemned such speculative business.

5. Profit in Islam:

Islam has ordained transparency in respect of features/qualities of the merchandise and honesty in dealing. In a

market where buyers and sellers trade with liberty, the parties can bargain on any price. In Sunan Abu Daud, we

come across a very interesting instance. The holy Prophet (pbuh) sent one of his Companions („Urwah) to

purchase for him a goat and gave him one dinar. Urwah went to the market and purchased two goats for one dinar,

then sold one of them in the market for one dinar and gave the holy Prophet a goat and also one dinar. The holy

Prophet was so happy with his honesty and expertise that he prayed for the promotion of his trade and business.

For getting the right of receiving profits over the principal one has to bear the risk of loss in business. The

important Shariah maxims: “Al Kharaj bi-al-Daman” or “Al Ghunm bil Ghurm” is the criterion of legality of any

return on capital, meaning that one has to bear loss, if any, if he wants to get any profit over his investment. Profit

has to be earned by sharing risk and reward of ownership through the pricing of goods, services or usufruct of

goods.

According to Muhammad Ayub, 2007, In all economic activities there could be some commercial risk and one has

to bear that risk for the validity of the profit or earnings. In other words, the return on invested funds that plays a

productive role in any business is a factor in the willingness and ability to cause “value addition” and bear the risk

of a potential loss in the business. Reward should depend on the productive behavior of the business where funds

are used, implying that interest, lotteries, gambling, etc. are prohibited, because return in respect of them either

does not accept the business risk or is based on pure luck, chance or hazard. In debt-creating modes, Islamic banks

will face credit/party risks, ownership transfer risks, market risks, commodity risks, price or rate of return risks,

legal and documentation risks and other mode-specific risks. Remaining within the Shariah principles, Islamic

banks are allowed to take risk mitigation/management measures. Hence, risk can be mitigated but not totally

eliminated. Transfer of commercial risk to anyone else without transferring the related reward is not permissible.

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6. Other Financial Transactions

Beside sale based transactions following other Financial Transactions are also allowed by Islam:

6.1 Profit sharing transactions:

Profit sharing transactions are of two types i.e. Shirkah and Mudarabah. Shirkah is any form of business where two

or more persons pool together their financial resources, entrepreneurship, skill or goodwill to venture into a certain

business activity. On the other han Mudarabah is the agreement between two parties (or more), whereby one party

will provide capital (thus becomes rab al-mal – capital provider) while the other party works with the capital (thus

becomes „mudarib – entrepreneur). (CIFP Module of Shariah Rules in Financial Transactions)

Both of these are also termed as equity based modes of financing. Profit sharing in both of these contracts is on the

basis of pre-agreed ratio. The case of loss is different for both, in Shirkah loss is to be borne on the percentage of

capital pooled by each party and in Mudarabah all loss is to be borne by Rab-ul-mal and the mudarib will only

loose the value of efforts he has made.

6.2 Leasing (Ijarah)

Leasing (Ijarah) means to employ the services of a person for a consideration (ujr) or sale of usufruct of a property

to another in exchange for consideration (ajr). The former one is known as Ijarah al-ashkhas and the latter one is

known as Ijarah al-a‟yan. Banks use Ijarh for financing assets, which at the end of renting period are to be

transferred to the name of lessee.

6.3 Fee based transaction

Wakalah and Kafalah are two transactions which are being used by Financial institutions for earning fee income.

The Majallah define wakalah as “(Agency) consists of one person empowering some other person to performsome

acts for him, whereby the later stands in the stead of the former in regard to such act”.

As far as Kafalah is concerned, Ibn Qudamah defined it as a conjoining of guarantor‟s liability to the liability of

the principal obligor for the discharge of a pecuniary obligation or debt or the delivery of property.

6.4 Free of Charge transaction:

Qard-e-hasan comes under the heading of free of charge transactions, as no profit is to be given to the creditor.

This is the only type of lending permissible in Islam. One type of deposits accepted by Islamic banks are on qard-

e-hasan basis. No profit is given to this type of deposit holders. On the other hand Qard-e-hasan can be given to the

poor to enable them to start their own business so that they could come out the bracket of poverty.

6.5 Supporting Transactions:

I will discuss Hawalah, Rahn and Wadiah contracts under this heading. Hawalah is an arrangement by which a

debtor got freedom from a debt cy another becoming responsible for it. According to Lane Rahn can be defined as

“to pledge or lodge a real or corporeal property of material value in accordance with law as security for a debt or

pecuniary obligation”. Wadiah is an implicit or explicit empowerment of another for safekeeping of one‟s

property. Banks accept deposits under this contract as well.

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7. Gray Areas

7.1 Use of Hiyal

Fiqh literature contains mention of a number of legal ruses that people have used to circumvent the prohibition of

Riba. Fat¯awa Alamgiri, Mahmas¯ani‟s Falsafa al Tashri, Sh¯atbi‟s al Mowafaq¯at, etc. contain reference to many

techniques that people used to make transactions technically permissible. (Ali, n.d., 10, p. 355–364). This is what

is called use of Hiyal.

Mahmasani, 1961 narrates the following bases for the prohibition of Hiyal:

“First – the Shar¯ı´ah texts are not aimed at the deeds themselves but rather at the interest which those deeds are

intended to serve. Therefore, all acts should be interpreted in the light of their spirit and intent and not by their

appearances _ _ _ Second – attempts at bypassing the law are tantamount to deceit, and deceit is prohibited in

Shar¯ı´ah as evidenced by the Qur‟¯an and the Sunnah _ _ _ Third – the Prophet, the Companions and the

Followers have been quoted in opposition to legal fictions _ _ _ Ibn Masud and Ibn Abbas, following the example

of the Prophet, were reported to have ruled against acceptance of a gift from the debtor before settlement of the

debt, because the purpose of a gift under such circumstances was the postponement of payment of the debt and a

ruse to legalize interest. Similarly, Muslim jurists, their followers and the doctors of traditions such as Imam

Bukhari agreed on the prohibition of legal fictions and on the necessity of avoiding them”.

According to Mahmasani, ruses or subterfuges are against the Shari‟i spirit and are not permissible. The Shafi„e,

Malikis and Hanbalis have declared the use of Hiyal as haram and totally prohibited, while according to Hanafis,

only such Hiyal are permissible as are compatible with the spirit of the Shariah.

7.2 Bai‟ Al-Inah

Inah is a two party transaction where a person sells an asset to another for cash and then immediately repurchases

the same from the buyer at a higher price to be paid normally in future/installment.

Scholars in favour of Inah say that Even though there are 2 transactions but they are independent transactions, each

is valid on its own footing, it is being done without expressed intention to do the linking, only be done when buyer

in the transaction has taken delivery of the purchased asset, as such as new owner he is free to sell the same to any

party including the seller himself and ownership right cannot be question by mere suspicion on his motive as such

right is so fundamental in Shariah such it acts as general principle. They also argue that Hadith/authorities cited in

banning Inah is not authoritative enough to quash this general principle.

Inah comes under gray area because of the arguments of majority of scholars are against it. They say that Intention

of the parties to affect lending with interest can be inferred by looking at the way they have behaved, there are

seemingly two transactions tied into one resulting in lending and not true sale, it is more of loan with interest in

essence and Hadith provisions and general rules governing sales not in favour of allowing Inah. The suspicion

points regarding Inah are: 1) The seller in the first transaction is in need of cash 2) The buyer is ready to facilitate

with a view to concluding the second transaction on much higher price 3) The price in the second sale in higher

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than the first one due to credit element and 4) if the financier/buyer is known riba‟ practitioner/ahl al-inah the

suspicion is even bigger.

7.3 Organized Tawarruq:

Let us first define Tawarruq, The Islamic Fiqh Academy of Jeddah has described tawarruq as “the purchase of a

commodity that is in the ownership and possession of the seller against a deferred price, and its subsequent sale by

the purchaser to a party other than the seller on cash, for the purpose of obtaining cash, that is, wariq”.

When the parties are known to each other and everything is preplanned then the Tawarruq is known as organized

Tawarruq. This type of Tawarruq is being practiced by the banks nowadays. Organized Tawarruq is condemned by

contemporary scholars because the client is found to do little other than expressing the amount of cash required by

him. Regulated tawarruq offered and carried out by some Islamic banks strongly indicates a willing cooperation

aimed at supplying cash against a higher credit obligation. It is prominent that organized tawarruq borne strong

resemblance borne to a hilah for attainment of riba. And the objective only happens to be obtaining cash from the

bank against undertaking a debt to be settled in installments.

7.4 Murabaha Sukuks:

According to AAOIFI sukuk must not represent receivables or debts, except in the case of a trading or financial

entity selling all its assets, or a portfolio with a standing financial obligation, in which some debts, incidental to

physical assets or usufruct, were included unintentionally. This recommendation is related to the first point raised

by AAOIFI above where sukuk holders should stand in the line of owners of underlying assets and not in the line

of creditors. Murabaha sukuks basically represent receiveable, that is why Murabaha Sukuks are not acceptable as

already mentioned Islam prohibits commercialization of debt.

As such, in order to be tradable, sukuk should not be backed purely by receivables. In sukuk securitization, the

underlying assets should be sold to the investors. If the originator were to become insolvent, the legal ownership of

the properties would reside with the investors, thus providing the necessary protection to them.

7.5 Equity based Sukuks & Fixed income:

The fundamental characteristics of equity-based Sukuk are rooted in two basic features: first, the capital cannot be

guaranteed; and second, the periodic returns are also dependent on actual profits made and can be variable.

However, these strict Shariah prescriptions for equity-based Sukuk structure may not be attractive to risk-averse

investors with a conventional mindset. In particular, the characteristics of mudarabah and musharakah do not meet

the risk appetite of investors who mainly expect capital preservation and fixed-income instruments as commonly

featured in conventional bond instruments (Ghani , B. A. (2009). Over time, the structure of equity-based Sukuk

has evolved into debt-based obligation, whereby various „credit enhancements‟ and strategies were introduced to

the mudarabah and musharakah Sukuk structures to achieve capital protection and predictable periodic returns

similar to other fixed-income or bond instruments. These innovations made in structuring Sukuk , which try to

achieve the same economic outcome like conventional instruments, distort the vision of Islamic economics based

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on justice and equitability. These visions are deeply inscribed in the objectives of Shariah, also known as Maqasid

al-Shariah. This distortion stems from the restricted view of understanding Shariah, by only focussing on the legal

forms of a contract rather than the substance especially when structuring a financial product. The overemphasis on

form over substance leads to potential abuse of Shariah principles in justifying certain contracts, which in fact are

contradictory to the Shariah text and ultimately undermining the higher objectives of Shariah. In the final analysis,

this article concludes that the substance of a contract that has greater implications to the realization of Maqasid al-

Shariah should be equally looked into. Otherwise, Islamic finance just appears as an exercise of semantics; the

functions and operations are really no different from conventional banks, except in the use of euphemisms to

disguise interest and circumvent the many Shariah prohibitions. (Journal of Financial Services Marketing (2010)

15, 203 – 214. doi: 10.1057/fsm.2010.17)

8. Difference between Conventional and Islamic trading framework

8.1 Basic Philosophy

The differences between conventional and Islamic trading framework starts from very basics. The base of

conventional economics lies on self interest and materialism, Adam Smith considered man as he is: dominated by

self-love, but without much altruistic concern for others. The conventional trading framework is also based on the

concept of profit maximization without other considerations. In process of getting maximized profit they started

practicing things which are against the very nature of trading i.e. Riba. Riba is not only prohibited in Islam but also

in Christianity and Judaism. The concepts of business ethics and corporate social responsibility are being accepted

by the conventional trading practitioners only in the last century. On the other hand Islamic trading framework is

based on absolute justice and fairplay. Earning wealth is allowed by Islam but only through hilal sources, it is

considered as ibadah. Perfect honesty in business and truthfulness in trade are much emphasised by the Holy

Prophet (pbuh). It will not be an exaggeration to say that absolute honesty in business and commerce is really an

Islamic concept. Islam defines trading framework in which you have to follow what God‟s interest is. Islam

forbade all the activities which are unjust for individuals and society and that is also the primary reason of the

prohibition of Riba.

8.2 Profit vs Riba

Holy Quran (verses 2: 275, 276) infer that Riba on loans and debts must not be equated with trade or profit from

sale. The permissibility of trading in the verse precedes the prohibition of Riba, which fact signifies that the

alternative to Riba is trading. An important difference between profit and Riba is that the former is a result of real

investment activity in which the business risk is allocated more evenly among all the parties involved, whereas in

Riba-based business, reward is guaranteed to a party leaving the other party in risk. Riba-based transactions do not

meet the Shariah requirement of “Al-Kharaj bi-al-Daman”, which signifies that one can claim profit only if he is

ready to take liability – bear the business risk, if any. The rationale of this principle is that earning profit is

legitimized by engaging in an economic activity and thereby contributing to the development of resources and

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society. The profit margin earned by a trader is justified firstly because he provides a definite service in the form of

seeking out, locating and purchasing goods for his client, for which he is allowed to charge a certain amount of

profit, and secondly, he takes business risk in obtaining the goods, like damage in storage or in transit and market

and price risks. All these activities and risks justify his earning a profit, even if the margin of profit in the case of a

credit sale of a commodity is more than the margin involved in the cash market price of that commodity. The

Shariah permits a trader to sell for cash or on credit subject to the condition that the price, once agreed between the

parties at the time of bargain, is not changed, even if the payment is not made by the due date. On the other hand,

earning money from money on the basis of interest creates a rentier class, giving a smaller and smaller share of the

national produce to those doing real work for the creation of wealth in the economy. Islamic financial institutions,

while undertaking trade services, have to fulfil the conditions required for valid sales. The permissibility of a

higher credit price than the cash price will be discussed in a subsequent section of this chapter.

8.3 Time value of money:

All consumption and production activities take time that is the reason of emergence of the concept “time has

value”. Time is a valuable economic resource. Conventional framework also applies the same concept in debt

instruments. Interest is justified in conventional framework on the basis of time value of money. But in Islam, time

value of money can only be recognized in trading and not in Qard or Dayn, because the latter are just considered as

charitable acts in Islam and hence any kind of getting increase in amount is strictly prohibited. Credit prices of

commodities are usually higher than its cash price; this is the evidence which proofs the acceptance of time value

of money in Islam. On the other hand in the case of credit sales in conventional trading, they see everything with

respect to debt and calculate time value accordingly. The holy Prophet (pbuh) has said that after making a loan, the

creditor must refrain from accepting any gift unless exchange of such gifts was in practice between the borrower

and the lender before the advancement of loan.

8.4 Options in sales:

Options in sales given by Islam are quite different from the options being practiced in the future and forward

markets. In conventional trading framework, relationship between the two parties is that of lender and borrower, so

there is no question of giving such option to buyer. But in Islam, trading is a genuine economic activity where the

real assets are being exchanged, and therefore Shariah for ensuring justice demands that the seller should disclose

the defects, if any, prior to the sale, otherwise the sale will be deemed invalid. Even when a sale is executed, free

from any grounds illegalities, it may still not be binding on both the parties, if Khiyar al-Shart is provided in the

contract.

The Shariah also provides option to the less informed party in the contract, whereby he can cancel the contract

within a specified period. Apart from the above mentioned options, the buyer has the two other options, namely

Khiyar al-Roiyyat and Khiyar al-Aib, without any stipulation with regard to thing he has purchased without seeing.

These two options give buyer power to cancel the contract, if the product do not conforms to the specifications.

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Regarding Khiyar al-Roiyyat, there are different opinions as to whether the sale of unseen items is binding or not.

According to Ibn Hazm, if a person purchases an unseen commodity but the seller has sufficiently described its

features and the commodity conforms to those features, it would be unjust not to purchase the commodity by using

Khiyar al-Roiyyat. These sorts of flexibilities are not present in conventional trading framework.

8.5 Gharar and speculative activities:

In conventional trading framework there is no prohibition that how much uncertainty is involved in a transaction.

Higher the uncertainty in a transaction more would be the profit. Same is the case with speculative activities,

where the speculators are actually not intending to buy any asset and just want to earn from price fluctuations due

to these activities. On the other hand only minimal uncertainty is allowed in transaction. Islam prohibits all those

transactions which have huge amount of uncertainty involved in them. Isam only allows the sale and purchase of

real assets with the intention to use or resell and earn profit from it. Islam disallows speculative activities where

the intention is to earn from the fluctuation of price due to speculative activities.

8.6 Derivatives:

According to Muhammad Ayub The conventional options, swaps and futures stem from debts and involve sale and

purchase of debts/liabilities. As a group, products such as interest-rate swaps, stock options and futures, currency

futures etc are called derivatives i.e. instruments derived from the expected future performance of the respective

underlying assets. The institutions dealing in derivates and hedge funds claim that diversity of hedging products

protect their clients against market volatility and provide a larger spectrum of risk management to the benefit of

the society. But, actually volatility is caused by their activities when they trade in derivatives as a part of rip-off

factor and the clients are sold nothing for something – protection against a danger that never needed to exist in the

first place. They may produce huge profits for financial institutions at the cost of others. But these profits are not

necessarily indicative of productive efforts. Mr. Warren Buffet, Chairman Berkshire Hathaway says: Derivatives

are financial weapons of mass destruction mainly due to opaque pricing and accounting policies in swaps, options

and other complex products whose prices are not listed on exchanges; Credit derivatives and total return swaps that

are agreements to guarantee counterparty against default or bankruptcy merit special concern (Buffet, Warren, The

Economist, March 15, 2003).”

Most of the derivatives incorporate gharar (absolute risk), gambling and interest and support speculative activities.

Islamic legal rules, particularly the ban on Gharar and on the sale of debt for debt, do not allow transactions devoid

of real/productive activities. Derivatives involving such financial contracts which themselves are prohibited in

Shariah (Riba based bonds & forward foreign exchange where mutual exchange is not simultaneous, for example)

are clearly un-acceptable according to the Shariah principles. In case the underlying assets are equities and

commodities it would be seen whether or not Riba and Gharar are involved. Experts are of the view that even in

case of acceptable forms of underlying assets, a key valuation element in arriving at the fair value of an option

contract remains the rate of interest.

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8.7 Dealing in Haram things and activities

The main focus of conventional trading frame work is profit maximization. No matter from where it comes, they

have even legalized prostitution. On the other hand Islam has specified the haram things, dealing in which is

prohibited in Islamic trading framework. These things include wine, swine, sale of debt, prostitution, soothsaying

etc. Islam allows transacting in any other thing except what are specified as haram.

صل ى األ ياء ف ش احة األ تى اإلب دل ح يل ي دل لى ال م ع تحري ال

In origin all thing in muamalaat are permissible unless prohibited by evidence (Quran & Sunnah)

9. Government Intervention in Market Place

Islam promotes a market free from interferences such as price fixing and hoarding. Government intervention,

however, is tolerated under specific circumstances. Islam prohibits the fixation of a price by a handful of buyers or

sellers who have become dominant in the market. During the days of Muhammad SAW, a small group of

merchants used to meet agricultural producers outside the city and bought the entire crop, thereby gaining

monopoly over the market. The produce was later sold at a higher price within the city. Muhammad SAW

condemned this practice since it caused injury both to the producers (who in the absence of numerous customers

were forced to sell goods at a lower price) and the inhabitants of Medina.

Producers and consumers should not be denied information on demand and supply conditions. Producers are

expected to inform consumers of the quality and quantity of goods they claim to sell. Some scholars hold that if an

inexperienced buyer is swayed by the seller, the consumer may nullify the transaction upon realizing the seller's

unfair treatment. The Qur'an also forbids discriminatory means of transaction.

Government interference in the market is justified in exceptional circumstances, such as the protection of public

interest. Under normal circumstances, government non-interference should be upheld. When Muhammad was

asked to set the price of goods in a market he responded, "I will not set such a precedent, let the people carry on on

with their activities and benefit mutually."

10. Business Ethics in Islam

Islam is a religion which regulates and directs life in all its departments. Islam is not like what is nowadays being

called as modern man‟s religion which is just a personal and private affair and has nothing to do with economic

and political life as effectively operative in our commerce and politics as in our domestic life and social relations.

That is the reason why perfect honesty in business and truthfulness in trade are much emphasised by the Holy

Prophet (may peace be upon him). It will not be an exaggeration to say that absolute honesty in business and

commerce is really an Islamic concept. Prophet Muhammad (may peace be upon him) who, on the one hand, urged

http://en.wikipedia.org/wiki/Price_fixing

http://en.wikipedia.org/wiki/Hoarding

http://en.wikipedia.org/wiki/Muhammad

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his followers to adopt trade as their profession, and, on the other band, exhorted them to observe truthfulness and

honesty in their business transactions (Muhaamad Ayub, 2007).

Islam has disallowed all transactions not based upon justice and fairplay The Holy Prophet (may peace be upon

him), while reprimanding the dishonest dealer, said: "Laisa minna man gashshdna" (Whosoever deceives us is not

one of us). According to Imam Ghazali, a Muslim who makes up his mind to adopt trade as a profession or to set

up his own business should first acquire a thorough understanding of the rules of business transactions codified in

the Islamic Shari'ah. Without such understanding he will go astray and fail into serious lapses making his earning

unlawful.

The Holy Qur'an has stressed the importance of fairness in business: "And, O my people, give full measure and

weight justly, and defraud not men of their things, and act not corruptly in the land making mischief. What remains

with Allah is better for you, if you are believers" (Al-Quran 9, 85-86). In these words addressed by Hadrat Shu'aib

to his people, the Holy Qur'an enunciates the fundamental principles of commerce as follows:

i. To give just measure and weight.

ii. Not to withhold from the people the things that are their due.

iii. Not to commit evil on the earth with the intent of doing mischief.

iv. To be contented with the profit that is left with us by God after we have paid other people their due.

We are told in these verses that commerce can flourish under conditions of peace and security. If one ponders over

the forms of transaction prohibited by Islam, one can arrive at the following ethical guidelines for doing business:

i. Islam insists upon absolute justice and fairplay in business dealings.

ii. According to Islam, a person who sacrifices his faith, and loses the good pleasure of his Lord to make a

monetary gain has not made a good bargain. A Muslim will not go in for such a bad bargain. A Muslim

merchant is not a worshipper of the Mammon with an inordinate love for money. He prizes faith, piety and

righteousness above all.

iii. Islam does not believe in the view that all is fair in business and that every kind of cleverness and deceit is

justifiable in business transactions. Islam regards business or commerce as an economic activity to be

carried on in a spirit of humanity. tarianism and justice. It does not approve of the cut-throat competition.

Indeed, the very concept is un-Islamic.

iv. Islam expects the buyer and the seller to look upon each other as Muslim brethren or fellow human beings,

each trying to go all his way to help and serve the other. It the seller happens to overcharge the buyer, he,

instead of feeling proud of his cleverness in doing so, should somehow compensate him for the excessive

payment received.

v. All bargains that are clenched without giving the purchaser a fair chance of examining the things are

prohibited because this amounts to denying him a right that was his due.

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vi. Forcible transactions or transactions in which the buyer takes undue advantage of the helplessness or

misery of the seller are also discouraged.

vii. Islam has prohibited traffic in wine, swine, dead bodies of animals and other goods the use of which has

been declared to be Haram (unlawful).

viii. It has also forbidden trading in things that have a debasing or vitiating influence on the Muslim society.

11. Summary:

All commercial transactions must be governed by the respective rules and norms of Islamic ethics, as enunciated

by the Shariah. The Islamic system disapproves of any exploitation or injustice on the part of any of the parties

involved. To achieve this objective, the Shariah has advised some prohibitions and recommended some ethics.

Detailed study of the rules and norms reveals that Islamic finance is, in essence, an ethical system and ethics need

to be an inseparable part of the system. What is not prohibited is permissible. Therefore, all contracts are valid

unless they violate the text of the Holy Quran or Sunnah of the holy Prophet (pbuh), or are in conflict with the

objectives of the Sharah. A property is either a specific existent object, e.g. a house, or an object defined

generically or abstractly by an obligation (Dayn). One can subdivide sale according to the types of Mabi„ being

exchanged. The mode of Murabaha can be used in trading of „Ayn and merchandise and not in credit documents or

Dayn.

The prohibition of sale of a debt for a debt affects when obligations (to perform or to pay) are delayed, and when

such obligations may be bought, sold or otherwise transferred.

In a transaction, any of the two counter values can be postponed, i.e. payment of the price, or delivery of the

commodity. While the former is a credit sale or Bai„ Mu‟ajjal, the latter refers to a future sale wherein the goods

sold are to be supplied later against prepaid price (Salam). Any contracts must be made as explicit as possible in

order to avoid Gharar and injustice to any of the parties. A clause in the contract allowing a change in liability

beyond the control of the liable party would be unjust, e.g. the client in Murabaha agrees that the bank can change

his liability whenever the latter likes, or the client agrees to automatic compensation for the bank in case of his

failure to meet the liability. Commercial contracts have to be concluded at a price that is agreed mutually without

uncertainty or hazard (Gharar) with regard to the subject matter and the counter value or consideration and the

seller‟s ability to deliver. A valid contract must comprise the following intrinsic elements:

The form, i.e. offer and acceptance, which can be conveyed by spoken words, in writing or through

indication and conduct. The acceptance should conform to the offer in all its details.

The contracting parties, who must have the capacity for execution.

The subject matter, which must be lawful, in actual existence at the time of the contract and should be

capable of being delivered and precisely determined either by description or by inspection/examination.

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If the contract is one of sale, it must be non-contingent and effective immediately, because the sale of goods

attributable to the future is void in the opinion of the majority of scholars. The arrangement of “two contracts into

one contract” is not permissible in Shariah; therefore, we cannot have the agreement of hire and purchase in one

contract, we can only undertake/promise to purchase the leased asset.

Generally, Islam prohibits all transactions that depend just on chance and speculation, those in which the rights of

the contracting parties are not clearly defined and those that enable some to amass wealth at the expense of others

and which could result in litigation. Such transactions involve appropriation of other‟s wealth without right or

justice. Practices like Riba, Gharar, fraud, dishonesty, false assertions and breach of contracts and promises also

lead to injustice. In every instance of prohibited business conduct one can discern an element of injustice, either to

one of the contracting parties or to the general public. In some such cases, the injustice may not be apparent, yet it

is always there. In order to nip evil in the bud, Islam seeks to block all those channels that eventually lead to

injustice. Conventional trading framework includes many transactions which contradict with Islamic rules, because

it is based on riba and gharar.

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12. References

http://www.iium.edu.my/deed/hadith/muslim/smtintro.html

http://en.wikipedia.org/wiki/Islamic_economic_jurisprudence

CIFP module on Shariah Rules in Financial Transactions

Alhasna, H. (2007), CIFP module on Shariah Aspects

Zuhayli, W. (2004). al-Fiqh al-Islami wa adillatuh. Beirut: Dar al-Fikr.

Ghazali, (A.H.1973) al-Mustafa min al-ilm al-Usul Cairo: al-Maktabah al-Tijariyyah.

Ayub, Muhammad, 2007, Understanding Islamic Finance. John, Wiley & Sons Ltd.

Muslim, 1981, with annotation by Nawavi

Buffet, Warren, The Economist, March 15, 2003

The Mejelle translated by C.R. Tyser, D.G. Demetriades and Ismail Haqqi Effendi.

Usman M. I. A., Meezan bank‟s guide to Islamic Banking.

Hammad, Nazih (1990) Studies in Principles of Debts in Islamic Fiqh. Taif, Dar Al Farooq, KSA.

http://www.iium.edu.my/deed/hadith/muslim/smtintro.html

sh 1003-shariah rules assignment

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